I love extremes!
The stock and other financial markets, or parts of them, are prone to exhibiting “extreme” behavior. Extremes are frequently depicted as record-breakers: things like record high oil prices, record low interest rates or record stock price moves up or down. Extremes are typically a signal, not noise. In other words, extreme conditions are CLEAR INDICATORS that tell you to jump in or stay away. Extreme conditions make it easy to formulate investment decisions.
Often after an “extreme” event, there is a market reaction, frequently countervailing or opposite. For example, an extreme price increase is often followed by a dramatic price decrease or some other opposite-like event. Countervailing events are not a guarantee. I cannot guarantee whether or exactly when an extreme price decline will follow an extreme price increase, because, unlike classical physics, there are no fixed laws of financial markets. Instead of guaranteeing a countervailing move following an extreme, let’s just say that a countervailing move has a high probability.
When housing prices reached records in 2007-early 2008, hordes of people started buying houses, often to “flip” them. Really bad move! Housing reached an extreme. These late-stage house flippers, fueled by greed and FOMO, should have stayed away until things cooled. Instead, many went bankrupt during the crash of 2008-2009.
During and after the recent pandemic, interest rates fell to record historic lows (even “negative”), and they stayed down there for a while. This was an easily recognized extreme. Was there a countervailing event off this extreme? YES – surging inflation and rising interest rates in 2022-2023.
Sometimes during extreme conditions, it is difficult or impossible to figure out exactly what the countervailing reaction will be. But most likely SOMETHING dramatic will happen, and you can take protective action. If housing prices reach an extreme, stay out of the house-flipping business for a bit, or sell a real estate property you bought a while ago.
Just last Friday (6/30/2023), it was pointed out that the NASDAQ market index had its second-best half-year (by percentage increase) since its inception in 1985. To me, this qualifies as an extreme or close to one (not a total record breaker). There is a high probability of a NASDAQ cooling. Until this happens, I will avoid investing in the highest-flying NASDAQ-type stocks, and maybe I will trim a few positions I hold. Even if I am wrong, I will live.